The Best Way to Enhance the Credibility of the Financial Statements Is by Means of the External Audit

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Audit Framework 2011/12

Coursework

Student name: Hoai Phuong Le
ID number: U0870879
Pathway: BA Accountancy – Final Year

Word count: 2490
The purpose of a statutory audit is defined in law. Its function is to report to the shareholders, on whether the financial statements show a true and fair view, have been properly prepared in accordance with the Companies Act and the applicable financial reporting framework (Shah, 2009, pp72-73). It is believed that the financial statements which have been scrutinised by a highly qualified and independent professional should become more reliable. However, there has been a lot of debate about how much reliance can be placed on the auditor’s report and how much credibility it actually adds to the financial statements. This essay will discuss the content of an audit report with regards to its structure and main wordings to evaluate if an auditor’s report has successfully communicated to stakeholders that the financial statement of a limited company are credible. First of all, the purpose of an external audit is to ensure that a company’s internal controls, operating, guidelines and policies are adequate, effective and in compliance with govermental requirements, accounting standards and company policies. The audit process makes sure that reporting machanisms prevent errors and fraud in financial statement and also provides full assurance to investor and financial market participants of the truth and fairness of a company’s accounting records. Auditor plays an important role in improving confidence in the integrity of an organisation’s process and procedure relating to internal control and financial reporting.

The wording of an audit report has been carefully determined by accounting profession to communicate precisely what an adit does and does not do. A standard audit report is usually headed by the words ‘the independent auditor’s report’. The emphasis should be on the word ‘independent’ because the opinion in the audit report should be given by a person who has no financial or other interest in the company. The fact that the auditor is independent should enhance the value of the opinion. Great emphasis is placed on the independence of auditors because some commentators believe that if it were not for the discipline imposed by the annual audit then company directors would, basically, prepare financial statements to serve their interest which may not necessarily be in compliance with accounting standards. The auditors are perceived to be free from bias to communicate an honest and professional opinion on the truthfulness and fairness of the accounts. In turn, this would add to the credibility of audited financial statements. On the other hand, there are opinions that auditors are not independent enough. A lack of independence undermines opinions presented in the audit report; and if the audit report cannot be relied on then its presence does not add any value to the credibility of the accounts. An auditor’s independence can be compromised in different ways. Familiarity with the clients can deter auditors from expressing opinions which may strain the business relationship. Also, self interest threat when the auditor becomes heavily involved in the management of the company may impair his perceived independence. There has been a great deal of interest from commentators about the independence of auditors, with particular reference to the level of fees which they earn from providing ‘non-audit services’. This can be illustrated by reference to Northern Rock’s auditors Pricewaterhouse Coopers who is reported to earn bigger fees from helping the discredited building society to sell its loans and borrow funds than it did from performing the audit. It has been described as a ‘complete conflict of interest because it was then impossible for the auditors to refer adversely to these transactions in their audit report (Stewart, 2007). Clearly, if...
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